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FOREX−Trading−Strategy by Selzer−McKenzie

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      • From: Methodikus@xxxxxxxxxxxxxx
      • Date: Sat, 6 Sep 2008 01:30:07 −0700 (PDT)

The FOREX−Trading Strategy
Author D.Selzer−McKenzie

The foreign exchange market most often called the forex market, or
simply the FX market is the most traded financial market in the
world. We like

to think of the forex market as the Big Kahuna of financial markets.
The forex market is the crossroads for international capital, the
intersection through which global commercial and investment flows have
to move. International trade flows, such as when a Swiss electronics
company purchases Japanese−made components, were the original basis
for the development of the forex markets. Today, however, global
financial and investment flows dominate trade as the primary non−
speculative source of forex market volume. Whether its an Australian
pension fund investing in U.S. Treasury bonds, or a British insurer
allocating assets to the Japanese equity market, or a German
conglomerate purchasing a Canadian manufacturing facility, each cross−
border transaction passes through the forex market at some stage.

More than anything else, the forex market is a traders market. Its a
market thats open around the clock six days a week, enabling traders
to act on news and events as they happen. Its a market where half−
billion−dollar trades can be executed in a matter of seconds and may
not even move prices noticeably. Try buying or selling a half billion
of anything in another market and see how prices react.


Getting Inside the Numbers

Average daily currency trading volumes exceed $2 trillion per day.
Thats a mind−boggling number, isnt it? $2,000,000,000,000 thats a
lot of zeros, no matter how you slice it. To give you some perspective
on that size, its about 10 to 15 times the size of daily trading
volume on all the worlds stock markets combined.

Speculating in the currency market

While commercial and financial transactions in the currency markets


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                              FOREX−Trading−Strategy by Selzer−McKenzie
represent huge nominal sums, they still pale in comparison to amounts
based on speculation. By far the vast majority of currency trading
volume is based on speculation traders buying and selling for short−
term gains based on minute−to− minute, hour−to−hour, and day−to−day
price fluctuations. Estimates are that upwards of 90 percent of daily
trading

volume is derived from speculation (meaning, commercial or investment−
based FX trades account for less than 10 percent of daily global
volume). The depth and breadth of the speculative market means that
the liquidity of the overall forex market is unparalleled among global
financial markets.

The bulk of spot currency trading, about 75 percent by volume, takes
place in the so−called major currencies, which represent the worlds
largest and most developed economies. Additionally, activity in the
forex market frequently functions on a regional currency bloc basis,
where the bulk of trading takes place between the USD bloc, JPY bloc,
and EUR bloc, representing the three largest global economic regions.

Getting liquid without getting soaked

Liquidity refers to the level of market interest the level of buying
and selling volume available at any given moment for a particular
asset or security. The higher the liquidity, or the deeper the market,
the faster and easier it is to buy or sell a security.



        From a trading perspective, liquidity is a critical consideration

because it determines how quickly prices move between trades and over
time. A highly liquid market like forex can see large trading volumes
transacted with relatively minor price changes. An illiquid, or thin,
market tends to see prices move more rapidly on relatively lower
trading volumes. A market that only trades during certain hours
(futures contracts, for example) also represents a less liquid,
thinner market.

Around the World in a Trading Day

The forex market is open and active 24 hours a day from the start of
business hours on Monday morning in the Asia−Pacific time zone
straight through to the Friday close of business hours in New York. At
any given moment, depending on the time zone, dozens of global
financial centers such as Sydney, Tokyo, or London are open, and
currency trading desks in those financial centers are active in the
market.

Currency trading doesnt even stop for holidays when other financial
markets, like stocks or futures exchanges, may be closed. Even though

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                            FOREX−Trading−Strategy by Selzer−McKenzie

its a holiday in Japan, for example, Sydney, Singapore, and Hong Kong
may still be open. It might be the Fourth of July in the United
States, but if its a business day, Tokyo, London, Toronto, and other
financial centers will still be trading currencies. About the only
holiday in common

around the world is New Years Day, and even that depends on what day
of the week it falls on.

The opening of the trading week

There is no officially designated starting time to the trading day or
week, but for all intents the market action kicks off when Wellington,
New Zealand, the first financial center west of the international
dateline, opens on Monday morning local time. Depending on whether
daylight saving time is in effect in your own time zone, it roughly
corresponds to early Sunday afternoon in North America, Sunday evening
in Europe, and very early Monday morning in Asia.

Chapter 1: What Is the Forex Market?
The Sunday open represents the starting point where currency markets
resume trading after the Friday close of trading in North America (5
p.m. Eastern time). This is the first chance for the forex market to
react to news and events that may have happened over the weekend.
Prices may have closed New York trading at one level, but depending on
the circumstances, they may start trading at different levels at the
Sunday open.

Trading in the Asia−Pacific session

Currency trading volumes in the Asia−Pacific session account for about
21 percent of total daily global volume, according to a 2004 survey.
The principal financial trading centers are Wellington, New Zealand;
Sydney, Australia; Tokyo, Japan; Hong Kong; and Singapore. In terms of
the most actively traded currency pairs, that means news and data
reports fromNew Zealand, Australia, and Japan are going to be hitting
the

market during this session Because of the size of the Japanese market
and the importance of Japanese data to the market, much of the action
during the Asia−Pacific session is focused on the Japanese yen
currency pairs (explained more in Chapter 2), such as USD/JPY forex−

speak for the U.S. dollar/Japanese yen −− and the JPY crosses, like
EUR/JPY and AUD/JPY. Of course, Japanese financial institutions are
also most active during this session, so you can frequently get a
sense of what the Japanese market is doing based on price movements.
For individual traders, overall liquidity in the major currency pairs
is more than sufficient, with generally orderly price movements. In
some less liquid, non−regional currencies, like GBP/USD or USD/CAD,
price movements may be more erratic or nonexistent, depending on the

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                               FOREX−Trading−Strategy by Selzer−McKenzie

environment.



Trading in the European/London session

About midway through the Asian trading day, European financial centers
begin to open up and the market gets into its full swing. European
financial centers and London account for over 50 percent of total
daily global trading volume, with London alone accounting for about
one−third of total daily global volume, according to the 2004 survey.
The European session overlaps with half of the Asian trading day and
half of the North American trading session, which means that market
interest and liquidity is at its absolute peak during this session.
News and data events from the Eurozone (and individual countries like
Germany and France), Switzerland, and the United Kingdom are typically
released in the early−morning hours of the European session. As a
result, some of the biggest moves and most active trading takes place
in the European currencies (EUR, GBP, and CHF) and the euro cross
currency pairs (EUR/CHF and EUR/GBP). Asian trading centers begin to
wind down in the late−morning hours of the European session, and North
American financial centers come in a few hours later, around 7 a.m.
ET.



Trading in the North American session

Because of the overlap between North American and European trading
sessions, the trading volumes are much more significant. Some of the
biggest and most meaningful directional price movements take place
during this crossover period. On its own, however, the North American
trading session accounts for roughly the same share of global trading
volume as the Asia−Pacific market, or about 22 percent of

global daily trading volume.

The North American morning is when key U.S. economic data is released
and the forex market makes many of its most significant decisions on
the value of the U.S. dollar. Most U.S. data reports are released at
8:30 a.m. ET, with others coming out later (between 9 and 10 a.m. ET).
Canadian data reports are also released in the morning, usually
between 7 and 9 a.m. ET. There are also a few U.S. economic reports
that variously come out at noon or 2 p.m. ET, livening up the New York
after noon market. London and the European financial centers begin to
wind down their daily trading operations around noon eastern time (ET)
each day. The London, or European close, as its known, can frequently
generate volatile flurries of activity. On most days, market liquidity
and interest fall off significantly in the New York afternoon, which
can make for challenging trading conditions. On quiet days, the
generally lower market interest typically leads to stagnating price

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                             FOREX−Trading−Strategy by Selzer−McKenzie
action. On more active days, where prices may have moved more
significantly, the lower liquidity can spark additional outsized price
movements, as fewer traders scramble to get similarly fewer prices and
liquidity. Just as with the London close, theres never a set way in
which a New York afternoon market move plays out, so traders just need
to be aware that lower liquidity conditions tend to prevail, and adapt
accordingly.


Currencies and Other Financial Markets

As much as we like to think of the forex market as the be all and end
all of financial trading markets, it doesnt exist in a vacuum. You
may even have heard of some these other markets: gold, oil, stocks,
and bonds. Theres a fair amount of noise and misinformation about the
supposed interrelationship among these markets and currencies or
individual currency pairs. To be sure, you can always find a
correlation between two different markets over some period of time,
even if its only zero (meaning, the two markets arent correlated at
all).

Always keep in mind that all the various financial markets are markets
in their own right and function according to their own internal
dynamics based on data, news, positioning, and sentiment. Will markets
occasionally overlap and display varying degrees of correlation? Of
course, and its always important to be aware of whats going on in
other financial markets. But its also essential to view each market
in its own perspective and to trade each market individually. Lets
look at some of the other key financial markets and see what
conclusions we can draw for currency trading.

Gold

Gold is commonly viewed as a hedge against inflation, an alternative
to the U.S. dollar, and as a store of value in times of economic or
political uncertainty. Over the long term, the relationship is mostly
inverse, with a weaker USD generally accompanying a higher gold price,
and a stronger USD coming with a lower gold price. However, in the
short run, each market has its own dynamics and liquidity, which makes

short−term trading relationships generally tenuous. Overall, the gold
market is significantly smaller than the forex market, so if we were
gold traders, wed sooner keep an eye on whats happening to the
dollar, rather than the other way around. With that noted, extreme
movements in gold prices tend to attract currency traders attention
and usually influence the dollar in a mostly inverse fashion.

Oil

A lot of misinformation exists on the Internet about the supposed
relationship between oil and the USD or other currencies, such as CAD

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                             FOREX−Trading−Strategy by Selzer−McKenzie
or JPY. The idea is that, because some countries are oil producers,
their currencies are positively (or negatively) affected by increases
(or decreases) in the price of oil. If the country is an importer of
oil (and which countries arent today?), the theory goes, its currency
will be hurt (or helped) by higher (or lower) oil prices. Correlation
studies show no appreciable relationships to that effect, especially
in the short run, which is where most currency trading is focused.
When there is a long−term relationship, its as evident against the
USD as much as, or more than, any individual currency, whether an
importer or exporter of black gold. The best way to look at oil is as
an inflation input and as a lim−
iting factor on overall economic growth. The higher the price of oil,
the higher inflation is likely to be and the slower an economy is
likely to grow. The lower the price of oil, the lower inflationary
pressures are likely (but not necessarily) to be. We like to factor
changes in the price of oil into our inflation and growth
expectations, and then draw conclusions about the course of the USD
from them. Above all, oil is just one input among many.


Stocks
Stocks are microeconomic securities, rising and falling in response to
individual corporate results and prospects, while currencies are
essentially macroeconomic securities, fluctuating in response to wider−
ranging economic and political developments. As such, there is little
intuitive reason that stock markets should be related to currencies.
Long−term correlation studies bear this out, with correlation
coefficients of essentially zero between the major USD pairs and U.S.
equity markets over the last five years. The two markets occasionally
intersect, though this is usually only at the extremes and for very
short periods. For example, when equity market volatility reaches
extraordinary levels (say, the Standard & Poors loses 2+ percent in a
day), the USD may experience more pressure than it otherwise would
but heres no guarantee of that. The U.S. stock market may have
dropped on an unexpected hike in U.S. interest rates, while the USD
may rally on the surprise move.


Bonds

Fixed−income or bond markets have a more intuitive connection to the
forex market because theyre both heavily influenced by interest rate
expectations. However, short−term market dynamics of supply and demand
interrupt most attempts to establish a viable link between the two
markets on a short−term basis. Sometimes the forex market reacts first
and fastest depending on shifts in interest rate expectations.

At other times, the bond market more accurately reflects changes in
interest rate expectations, with the forex market later playing catch−
up.


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                              FOREX−Trading−Strategy by Selzer−McKenzie

Overall, as currency traders, you definitely need to keep an eye on
the yields of the benchmark government bonds of the major−currency
countries to better monitor the expectations of the interest rate
market. Changes in relative interest rates (interest rate
differentials) exert a major influence on forex markets.



The Mechanics of Currency



Trading

In This Chapter

Understanding currency pairs

Going long and short

Calculating profit and loss

Reading a price quote


The currency market has its own set of market trading conventions and
related lingo, just like any financial market. If youre new to
currency trading, the

mechanics and terminolgy may take some getting used to. But at the end
of the day, most currency trade conventions are pretty
straightforward.

Buying and Selling Simultaneously

The biggest mental hurdle facing newcomers to currencies, especially
traders familiar with other markets, is getting their head around the
idea that each currency trade consists of a simultaneous purchase and
sale. In the stock market, for instance, if you buy 100 shares of
Google, you own 100 shares and hope to see the price go up. When you
want to exit that position, you simply sell what you bought earlier.
Easy, right?

But in currencies, the purchase of one currency involves the
simultaneous sale of another currency. This is the exchange in foreign
exchange. To put it another way, if youre looking for the dollar to
go higher, the question is Higher against what?

The answer is another currency. In relative terms, if the dollar goes
up against another currency, that other currency also has gone down
against the dollar. To think of it in stockmarket terms, when you buy

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                             FOREX−Trading−Strategy by Selzer−McKenzie

a stock, youre selling cash, and when you sell a stock, youre buying
cash.

Currencies come in pairs

To make matters easier, forex markets refer to trading currencies by
pairs, with names that combine the two different currencies being
traded, or exchanged, against each other. Additionally, forex
markets have given most currency pairs nicknames or abbreviations,
which reference the pair and not necessarily the individual currencies
involved.

Major currency pairs

The major currency pairs all involve the U.S. dollar on one side of
the deal. The designations of the major currencies are expressed using
International Standardization Organization (ISO) codes for each
currency. Table 2−1 lists the most frequently traded currency pairs,
what theyre called in conventional terms, and what nicknames the
market has given them.

Table 2−1

The Major U.S. Dollar Currency Pairs

ISO Currency Countries Long Name Nickname Pair

EUR/USD Eurozone*/U.S. Euro−dollar N/A

USD/JPY U.S./Japan Dollar−yenN/A

GBP/USD United Kingdom/U.S. Sterling−dollar Sterling or Cable

USD/CHF U.S./Switzerland Dollar−Swiss Swissy

USD/CAD U.S./Canada Dollar−Canada Loonie

AUD/USD Australia/U.S.Australian−dollar Aussie or Oz

NZD/USD New Zealand/U.S. New Zealand−dollar Kiwi

* The Eurozone is made up of all the countries in the European Union
that have

adopted the euro as their currency.

Major cross−currency pairs

Although the vast majority of currency trading takes place in the
dollar pairs, cross−currency pairs serve as an alternative to always
trading the U.S. dollar. A cross−currency pair, or cross or crosses

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                               FOREX−Trading−Strategy by Selzer−McKenzie
for short, is any currency pair that does not include the U.S. dollar.
Cross rates are derived from the respective USD pairs but are quoted
independently. Crosses enable traders to more directly target trades
to spe−

cific individual currencies to take advantage of news or events. For
example, your analysis may suggest that the Japanese yen

has the worst prospects of all the major currencies going forward,
based on interest rates or the economic outlook. To take advantage of
this, youd be looking to sell JPY, but against which other currency?
You consider the USD, potentially buying USD/JPY (buying USD/selling
JPY) but then you conclude that the USDs prospects are not much
better than the JPYs. Further research on your part may point to
another currency that has a much better outlook (such as high or
rising interest rates or signs of a strengthening economy), say the
Australian dollar (AUD). In this example, you would then be looking to
buy the AUD/JPY cross (buying AUD/selling JPY) to target your view
that AUD has the best prospects among major currencies and the JPY the
worst. The most actively traded crosses focus on the three major non
USD currencies (namely EUR, JPY, and GBP) and are referred to as euro
crosses, yen crosses, and sterling crosses.

The long and the short of it

Forex markets use the same terms to express market positioning as most
other financial markets. But because currency trading involves
simultaneous buying and selling, being clear on the terms helps
especially if youre totally new to financial market trading.

Going long

No, were not talking about running out deep for a football pass. A
long position, or simply a long, refers to a market position in which
youve bought a security. In FX, it refers to having bought a currency
pair. When youre long, youre looking for prices to move higher, so
you can sell at a higher price than where you bought. When you want to
close a long position,


Base currencies and counter currencies

When you look at currency pairs, you may notice that the currencies
are combined in a seemingly strange order. For instance, if sterling−
yen

(GBP/JPY) is a yen cross, then why isnt it referred to as yen−
sterlingand written JPY/GBP? The answer is that these quoting
conventions

evolved over the years to reflect traditionally strong currencies

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                             FOREX−Trading−Strategy by Selzer−McKenzie

versus traditionally weak currencies, with the strong currency coming
first.

It also reflects the market quoting convention where the first
currency in the pair is known as the base currency. The base currency
is what

youre buying or selling when you buy or sell the pair. Its also the
notional, or face, amount of the trade. So if you buy 100,000 EUR/JPY,

youve just bought 100,000 euros and sold the equivalent amount in
Japanese yen. If you sell 100,000 GBP/CHF, you just sold 100,000

British pounds and bought the equivalent amount of Swiss francs. The
second currency in the pair is called the counter currency, or the

secondary currency. Hey, who said this stuff isnt intuitive? Most
important for you as an FX trader, the counter currency is the
denomina−

tion of the price fluctuations and, ultimately, what your profit and
losses will be denominated in. If you buy GBP/JPY, it goes up, and you

take a profit, your gains are not in pounds, but in yen. (We run
through the math of calculating profit and loss later in this
chapter.)

you have to sell what you bought. If youre buying at multiple price
levels, youre adding to longs and getting longer.

Getting short

A short position, or simply a short, refers to a market position in
which youve sold a security that you never owned. In the stock
market, selling a stock short requires borrowing the stock (and paying
a fee to the lending brokerage) so you can sell it. In forex markets,
it means youve sold a currency pair, meaning youve sold the base
currency and bought the counter currency. So youre still making an
exchange, just in the opposite order and according to currency−pair
quoting terms. When youve sold a currency pair, its called going
short or getting short and it means youre looking for the pairs
price to move lower so you can buy it back at a profit. If you sell at
various price levels, youre

adding to shorts and getting shorter. In currency trading, going short
is as common as going long. Selling high and buying low is a
standard currency trading strategy. Currency pair rates reflect
relative values between two currencies and not an absolute price of a
single stock or com−

modity. Because currencies can fall or rise relative to each other,

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                             FOREX−Trading−Strategy by Selzer−McKenzie
both in medium and long−term trends and minute−to minute fluctuations,
currency pair prices are as likely to be going down at any moment as
they are up. To take advantage of such moves, forex traders routinely
use short positions to exploit falling currency prices. Traders from
other markets may feel uncomfortable with short selling, but its just
some−
thing you have to get your head around. Squaring up Having no position
in the market is called being square or flat. If you have an open
position and you want to close it, its called squaring up. If youre
short, you need to buy to square up. If youre long, you need to sell
to go flat. The only time you have no market exposure or financial
risk is when youre square.


Profit and Loss

Profit and loss (P&L) is how traders measure success and failure. A
clear understanding of how P&L works is especially critical to online
margin trading, where your P&L directly affects the amount of margin
you have to work with. Changes in your margin balance determine how
much you can trade and for how long you can trade if prices move
against you.

Margin balances and liquidations

When you open an online currency trading account, youll need to pony
up cash as collateral to support the margin requirements established
by your broker. That initial margin deposit becomes your opening
margin balance and is the basis on which all your subsequent trades
are collateralized.

Unlike futures markets or margin−based equity trading, online forex
brokerages do not issue margin calls (requests for more

collateral to support open positions). Instead, they establish ratios
of margin balances to open positions that must be maintained at all
times.

Heres an example to help you understand how required margin ratios
work. Say you have an account with a leverage ratio of 100:1 (so $1 of
margin in your account can control a $100 position size), but your
broker requires a 100% margin ratio, meaning you need to maintain 100%
of the required margin at all times. The ratio varies with account
size, but a 100% margin requirement is typical for small accounts.
That

means to have a position size of $10,000, youd need $100 in your
account, because $10,000 divided by the leverage ratio of 100 is $100.
If your accounts margin balance falls below the required ratio, your
broker probably has the right to close out your positions without any
notice to you. If your broker liquidates your position, that usually

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                              FOREX−Trading−Strategy by Selzer−McKenzie
means your losses are locked in and your margin balance just got
smaller.

Be sure you completely understand your brokers margin requirements
and liquidation policies. Requirements may differ depending on account
size and whether youre trading standard lot sizes (100,000 currency
units) or mini lot sizes (10,000 currency units). Some brokers
liquidation policies allow for all positions to be liquidated if you
fall below margin requirements. Others close out the biggest losing
positions or portions

of losing positions until the required ratio is satisfied again. You
can find the details in the fine print of the account opening contract
that you sign. Always read the fine print to be sure you understand
your brokers margin and trading policies.


Unrealized and realized profit and loss

Most online forex brokers provide real−time mark−to−market
calculations showing your margin balance. Mark−to−market is the
calculation that shows your unrealized P&L based on where you could
close your open positions in the market at that instant. Depending on
your brokers trading platform, if youre long, the calculation will
typically be based on where you could sell at that moment. If youre
short, the price used

will be where you can buy at that moment. Your margin balance is the
sum of your initial margin deposit, your unrealized P&L, and your
realized P&L. Realized P&L is what you get when you close out a trade
position, or a portion of a trade position. If you close out the full

position and go flat, whatever you made or lost leaves the unrealized
P&L calculation and goes into your margin balance.

If you only close a portion of your open positions, only that part of
the trades P&L is realized and goes into the margin balance. Your
unrealized P&L continues to fluctuate based on the remaining open
positions, as does your total margin balance. If youve got a winning
position open, your unrealized P&L is positive and your margin balance
increases. If the market is moving against your positions, your
unrealized P&L is negative and your margin balance is reduced. Forex
prices change constantly, so your mark−to−market unrealized P&L and
total margin balance also change constantly.

Calculating profit and loss with pips

Profit−and−loss calculations are pretty straightforward in terms of
math theyre all based on position size and the number of pips you
make or lose. A pip is the smallest increment of price fluctuation in
currency prices. Pips can also be referred to as points; we use the

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                             FOREX−Trading−Strategy by Selzer−McKenzie

two terms interchangeably. Looking at a few currency pairs helps you
get an idea what a pip is. Most currency pairs are quoted using five
digits. The placement of the decimal point depends on whether its a
JPY currency pair, in which case there are two digits behind the
decimal point. All others currency pairs have four digits behind the
decimal point. In all cases, that last itty−bitty digit is the pip.
Here are some major currency pairs and crosses, with the pip
underlined:

EUR/USD: 1.2853

USD/CHF: 1.2267

USD/JPY: 117.23

EUR/JPY: 150.65

Focus on the EUR/USD price first. Looking at EUR/USD, if the price
moves from 1.2853 to 1.2873, its just gone up by 20 pips. If it goes
from 1.2853 down to 1.2792, its just gone down by 61 pips. Pips
provide an easy way to calculate the P&L. To turn that pip movement
into a P&L calculation, all you need to know is the size of the
position. For a 100,000 EUR/USD position, the 20−pip move equates to
$200 (EUR 100,000 · 0.0020 = $200). For a 50,000 EUR/USD position, the
61−point move translates into $305 (EUR 50,000 · 0.0061 = $305).

Whether the amounts are positive or negative depends on whether you
were long or short for each move. If you were short for the move
higher, thats a in front of the $200, if you were long, its a +.
EUR/USD is easy to calculate, especially for USD−based traders,
because the P&L accrues in dollars. If you take USD/CHF, youve got
another calculation to make before you can make sense of it. Thats
because the P&L is

going to be denominated in Swiss francs (CHF) because CHF is the
counter currency. If USD/CHF drops from 1.2267 to 1.2233 and youre
short USD 100,000 for the move lower, youve just caught a 34−pip
decline. Thats a profit worth CHF 340 (USD 100,000 · 0.0034 = CHF
340). Yeah but how much is that in real money? To convert it into USD,
you need to divide the CHF 340 by the USD/CHF rate. Use the closing
rate of the trade (1.2233), because thats where the market was last,
and you get USD 277.94. Even the venerable pip is in the process of
being updated as electronic trading continues to advance. Just a
couple paragraphs earlier, we tell you that the pip is the smallest
increment of currency price fluctuations. Not so fast. The online
market is rapidly advancing to decimalizing pips (trading in pips) and
half−pip prices have been the norm in certain currency pairs in the
interbank market for many years.

Factoring profit and loss into margin calculations


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                             FOREX−Trading−Strategy by Selzer−McKenzie
The good news is that online FX trading platforms calculate the P&L
for you automatically, both unrealized while the trade is open and
realized when the trade is closed. So why did we just drag you through
the math of calculating P&L using pips?

Because online brokerages only start calculating your P&L for you
after you enter a trade.To structure your trade and manage your risk
effectively (How big a position? How much margin to risk?), youre
going to need to calculate your P&L outcomes before you enter the
trade.

Understanding the P&L implications of a trade strategy youre
considering is critical to maintaining your margin balance and staying
in control of your trading. This simple exercise can help prevent you
from costly mistakes, like putting on a trade thats too large, or
putting stop−loss orders beyond prices where your account falls below
the margin requirement. At the minimum, you need to calculate the
price point at which

your position will be liquidated when your margin balance falls below
the required ratio.

Understanding Rollovers and Interest Rates

One market convention unique to currencies is rollovers. A rollover is
a transaction where an open position from one value date (settlement
date) is rolled over into the next value date. Rollovers represent the
intersection of interest−rate markets and forex markets.

Currency is money, after all Rollover rates are based on the
difference in interest rates of the two currencies in the pair youre
trading. Thats because what youre actually trading is good old−
fashioned cash. When youre long a currency, its like having a
deposit in the bank. If youre short a currency, its like having
borrowed a loan. Just as you would expect to earn interest on a bank
deposit or pay interest on a loan, you should expect an interest gain/
expense for holding a currency position over the change in value.
Think of an open currency position as one account with a pos−

itive balance (the currency youre long) and one with a negative
balance (the currency youre short). But because your accounts are in
two different currencies, the two interest rates of the different
countries apply. The difference between the interest rates in the two
countries
is called the interest−rate differential. The larger the interest rate
differential, the larger the impact from rollovers. The narrower the
interest−rate differential, the smaller the effect from rollovers. You
can find relevant interest−rate levels of the major currencies from
any number of financial−market Web sites. Look for the base or
benchmark lending rates in each country.


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                              FOREX−Trading−Strategy by Selzer−McKenzie


Applying rollovers

Rollover transactions are usually carried out automatically by your
forex broker if you hold an open position past the change in value
date. Rollovers are applied to your open position by two offsetting
trades that result in the same open position. Some online forex
brokers apply the rollover rates by adjusting the average rate of your
open position. Other forex brokers apply rollover rates by applying
the rollover credit or debit directly to your margin balance. Heres
what you need to remember about rollovers: Rollovers are applied to
open positions after the 5 p.m. ET change in value date, or trade
settlement date. Rollovers are not applied if you dont carry a
position over the change in value date. So if youre square at the
close of each trading day, youll never have to worry about rollovers.
Rollovers represent the difference in interest rates

between the two currencies in your open position, but theyre applied
in currency−rate terms. Rollovers constitute net interest earned or
paid by you, depending on the direction of your position. Rollovers
can earn you money if youre long the currency with the higher
interest rate and short the currency with the lower interest rate.
Rollovers cost you money if youre short the currency with the higher
interest rate and long the currency with the lower interest rates.

Understanding Currency Quotes

Here, we look at how online brokerages display currency prices and
what they mean for trade and order execution. Keep in mind that
different online forex brokers use different formats to display prices
on their trading platforms.


Bids and offers
When youre in front of your screen and looking at an online forex
brokers trading platform, youll see two prices for each currency
pair. The price on the left−hand side is called the bid and the price
on the right−hand side is called the offer (some call this the ask).
The bid is the price at which you can sell the base currency. The
offer is the price at which you can buy the base currency.

Some brokers display the prices above and below each other, with the
bid on the bottom and the offer on top. The easy way to tell the
difference is that the bid price is always lower than the offer price.
The price quotation of each bid and offer you see will have two
components: the big figure and the dealing price. The big figure
refers to the first three digits of the overall currency rate and is
usually shown in a smaller font size or even in shadow. The dealing
price refers to the last two digits of the overall currency price and
is brightly displayed in a larger font size.


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                            FOREX−Trading−Strategy by Selzer−McKenzie
For example, in Figure 2−1 the full EUR/USD price quotation is
1.3493/95. The 1.34 is the big figure and is there to show you the
full price level (or big figure) that the market is currently trading
at. The 93/95 portion of the price is the bid/offer dealing price.
Figure 2−1: A dealing box from the FOREX.com trading platform for EUR/
USD shows the current bid and offer price. The bid (on the left) is
the price at which you can sell Euros. The offer on the right, is
the price at which you can buy Euros.



Spreads

A spread is the difference between the bid price and the offer price.
Most online forex brokers utilize spread−based trading platforms for
individual traders. Look at the spread as the compensation the broker
receives for being the market−maker and executing your trade. Spreads
vary from broker to broker and by currency pairs at each broker as
well. Generally, the more liquid the currency pair, the narrower the
spread; the less liquid the currency pair, the wider the spread. This
is especially the case for some of the less−traded crosses.

Currency Trading For Dummies, Getting Started Edition



Choosing Your Trading Style


In This Chapter

Determining what trading style fits you best Understanding the
different trading styles Developing and maintaining market discipline

Before you get involved in actively trading the forex market, take a
step back and think about how you want to approach the market. There
is more to currency trading than meets the eye, and we think the
trading style you choose is one of the most important determinants of
overall trading success. This chapter takes you through the main
points to consider as you define your own approach to trading
currencies. We review the characteristics of some of the most commonly
applied trading styles and discuss what they mean in concrete terms.
We also run you through the essential elements of developing and
sticking to a trading plan.


Finding the Right Trading Style for You
Were frequently asked, Whats the best way to trade the forex
market? Thats a loaded question that seems to imply theres a right
way and a wrong way to trade currencies. Unfortunately, there is no
easy answer. Better put, there is no standard answer one that

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                             FOREX−Trading−Strategy by Selzer−McKenzie

applies to everyone. The forex markets trading characteristics have
something to offer every trading style (long−term, medium−term, or
shortterm) and approach (technical, fundamental, or a blend). So in
terms of deciding what style or approach is best suited to currencies,
the starting point is not the forex market itself, but your own
individual circumstances and way of thinking.



Real−world and lifestyle considerations

Before you can begin to identify the trading style and approach that
works best for you, give some serious thought to what resources you
have available to support your trading. As with many of lifes
endeavors, when it comes to financial−market trading, there are two
main resources that people never seem to have enough of: time and
money. Deciding how much of each you can devote to currency trading
helps to establish how you pursue your trading goals. If youre a full−
time trader, you have lots of time to devote to market analysis and
actually trading the market. But because currencies trade around the
clock, you still have to be mindful of which session youre trading,
and of the daily peaks and

troughs of activity and liquidity. (See Chapter 1 for trading session
specifics.) Just because the market is always open doesnt mean its
necessarily always a good time to trade. If you have a full−time job,
your boss may not appreciate your taking time to catch up on the
charts or economic data reports while youre at work. That means
youll have to use your free time to do your market research. Be
realistic when

you think about how much time youll be able to devote on a regular
basis, keeping in mind family obligations and other personal
circumstances.

When it comes to money, we cant stress enough that trading capital
has to be risk capital and that you should never risk any money that
you cant afford to lose. The standard definition of risk capital is
money that, if lost, will not materially affect your standard of
living. It goes without saying that borrowed money is not risk capital
 you should never use borrowed money for speculative trading.
When you determine how much risk capital you have available for
trading, youll have a better idea of what size account you can trade
and what position size you can handle. Most online trading platforms
typically offer generous leverage ratios that allow you to control a
larger position with less required margin. But just because they offer
high leverage doesnt mean you have to fully utilize it.


Making time for market analysis


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                             FOREX−Trading−Strategy by Selzer−McKenzie

The full version of Currency Trading For Dummies talks about the
amount of data and news that flows through the forex market on a daily
basis and it can be truly overwhelming. So how can an individual
trader possibly keep up with all the data and news? The key is to
develop an efficient daily routine of market analysis. Thanks to the
Internet and online currency broker pages, independent traders can
access a variety of information.

Your daily regimen of market analysis should focus on:

Overnight forex market developments: Who said what, which data came
out, and how the currency pairs reacted.

Daily updates of other major market movements over the prior 24 hours
and the stories behind them: If oil prices or U.S. Treasury yields
rose or fell substantially, find out why.

Data releases and market events (for example, the retail sales report,
Fed speeches, central bank rate announcements) expected for that day:
Ideally, youll monitor data and event calendars one week in advance,
so you can be anticipating the outcomes along with the rest of the
market.

Multiple−time−frame technical analysis of major currency pairs: There
is nothing like the visual image of price action to fill in the blanks
of how data and news affected individual currency pairs.

Current events and geopolitical themes: Stay abreast on issues of
major elections, political scandals, military conflicts, and policy
initiatives in the major currency nations.

Technical versus fundamental analysis

Ask yourself on what basis youll make your trading decisions
fundamental analysis or technical analysis?

Fundamentals are the broad grouping of news and information that
reflects the macroeconomic and political fortunes of the countries
whose currencies are traded. Most of the time, when you hear someone
talking about the fundamentals of a currency, hes referring to the
economic fundamentals.

Economic fundamentals are based on:

Economic data reports

Interest rate levels

Monetary policy

International trade flows

FOREX−Trading−Strategy by Selzer−McKenzie                                18
                            FOREX−Trading−Strategy by Selzer−McKenzie


International investment flows

The term technicals refers to technical analysis, a form of market
analysis most commonly involving chart analysis, trend−line analysis,
and mathematical studies of price behavior, such as momentum or moving
averages, to mention just a couple. We dont know of too many currency
traders who dont follow some form of technical analysis in their
trading. Even the stereotypical seat−of−the−pants, trade−your−gut
traders are

likely to at least be aware of technical price levels identified by
others. If youve been an active trader in other financial markets,
chances are, youve engaged in some technical analysis or at least
heard of it. Followers of each discipline have always debated which
approach works better. Rather than take sides, we suggest following an
approach that blends the two disciplines. In our experience,
macroeconomic factors such as interest rates, relative growth rates,
and market sentiment determine the big−picture direction of currency
rates. But currencies rarely move in a straight line, which means
there are plenty of short term price fluctuations to take advantage of
 and some of them can be substantial.

Technical analysis can provide the guideposts along the route of the
bigger price move, allowing traders to more accurately predict the
direction and scope of future price changes. Most important, technical
analysis is the key to constructing a well defined trading strategy.
For example, your fundamental analysis, data expectations, or plain
old gut instinct may lead you to conclude that USD/JPY is going lower.
But where exactly do you get short? Where do you take profit, and
where do you cut your losses? You can use technical analysis to refine
trade entry and exit points, and to decide whether and where to add to
positions or reduce them.

Sometimes forex markets seem to be more driven by fundamental factors,
such as current economic data or comments from a central bank
official. In those times, fundamentals provide the catalysts for
technical breakouts and reversals. At other times, technical
developments seem to be leading the charge a break of trend−line
support may trigger stop−loss selling by market longs and bring in
model systems that are

selling based on the break of support. Subsequent economic reports may
run counter to the directional breakout, but data be damned the
support is gone, and the market is selling. Approaching the market
with a blend of fundamental and technical analysis improves your
chances of both spotting trade opportunities and managing your trades
more effectively. Youll also be better prepared to handle markets
that are alternately reacting to fundamental and technical
developments or some combination of the two.


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                             FOREX−Trading−Strategy by Selzer−McKenzie


Different Strokes for Different Folks

After youve given some thought to the time and resources youre able
to devote to currency trading and which approach you favor (technical,
fundamental, or a blend), the next step is to settle on a trading
style that best fits those choices. There are as many different
trading styles and market approaches in FX as there are individuals in
the market. But most trading styles can be grouped into three main
categories that boil down to varying degrees of exposure to market
risk. The two main elements of market risk are time and relative price
movements. The longer you hold a position, the more risk youre
exposed to. The more of a price change youre anticipating, the more
risk youre exposed to. In the next few sections we detail the three
main trading styles and what they really mean for individual traders.
Our aim here is not to advocate for any particular trading style,
because styles frequently overlap, and you can adopt different styles
for different trade opportunities or different market conditions.
Instead, our goal is to give you an idea of the various approaches
used by forex market professionals so you can understand the basis of
each style.


Short−term, high−frequency day trading

Short−term trading in currencies is unlike short−term trading in most
other markets. A short−term trade in stocks or commodities usually
means holding a position for a day to several days at least. But
because of the liquidity and narrow bid/offer spreads in currencies,
prices are constantly fluctuating in small increments. The steady and
fluid price action in currencies allows for extremely short−term
trading by speculators intent on capturing just a few pips (explained
in Chapter 2) on each trade.

Short−term forex trading typically involves holding a position for
only a few seconds or minutes and rarely longer than an hour. But the
time element is not the defining feature of short− term currency
trading. Instead, the pip fluctuations are whats important. Traders
who follow a short−term trading style are seeking to profit by
repeatedly opening and closing positions after gaining just a few
pips, frequently as little as 1 or 2 pips. In the interbank market,
extremely short−term, in−and−out trading is referred to as jobbing the
market; online currency traders call it scalping. (We use the terms
interchangeably.) Traders who follow this style have to be among the
fastest and most disciplined of traders because theyre out to capture
only a few pips on each trade. In terms of speed, rapid reaction and
instantaneous decision−making are essential to successfully jobbing
the market.

When it comes to discipline, scalpers must be absolutely ruthless in
both taking profits and losses. If youre in it to make only a few

FOREX−Trading−Strategy by Selzer−McKenzie                                20
                             FOREX−Trading−Strategy by Selzer−McKenzie
pips on each trade, you cant afford to lose much more than a few pips
on each trade. Jobbing the market requires an intuitive feel for the
market.

(Some practitioners refer to it as rhythm trading.) Scalpers dont
worry about the fundamentals too much. If you were to ask a scalper
for her opinion of a particular currency pair, she would be likely to
respond along the lines of It feels bid or It feels
offered (meaning, she senses an underlying buying or selling bias in
the market but only at that moment). If you ask her again a few
minutes later, she may respond in the opposite direction. Successful
scalpers have absolutely no allegiance to any single position. They
couldnt care less if the currency pair

goes up or down. Theyre strictly focused on the next few pips. Their
position is either working for them, or theyre out of it faster than
you can blink an eye. All they need is volatility and liquidity.
Retail traders are typically faced with bid/offer spreads of between 2
and 5 pips. Although this makes jobbing slightly more difficult, it
doesnt mean you cant still engage in short− term trading it just
means youll need to adjust the risk parameters of the style. Instead
of looking to make 1 to 2 pips on each trade, you need to aim for a
pip gain at least as large as the spread youre dealing with in each
currency pair. The other basic rules of taking only minimal losses and
not hanging on to a position for too long still apply. Here are some
other important guidelines to keep in mind when following a short−term
trading strategy:

Trade only the most liquid currency pairs, such as EUR/USD, USD/JPY,
EUR/GBP, EUR/JPY, and EUR/CHF.The most liquid pairs have the tightest
trading spreads and fewer sudden price jumps.

Trade only during times of peak liquidity and market interest.
Consistent liquidity and fluid market interest are essential to short−
term trading strategies. Market liquidity is deepest during the
European session when Asian and North American trading centers overlap
with European time zones about 2 a.m. to noon Eastern time (ET).
Trading in other sessions can leave you with far fewer and less
predictable short−term price movements to take advantage of.

Focus your trading on only one pair at a time. If youre aiming to
capture second−by−second or minute−by−minute price movements, youll
need to fully concentrate on one pair at a time. Itll also improve
your feel for the pair if that pair is all youre watching.

Preset your default trade size so you dont have to keep specifying it
on each deal. Look for a brokerage firm that offers click−and−deal
trading so youre not subject to execution delays or requotes. Adjust
your risk and reward expectations to reflect the dealing spread of the
currency pair youre trading.


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                              FOREX−Trading−Strategy by Selzer−McKenzie

With 2− to 5−pip spreads on most major pairs, you probably need to
capture 3 to 10 pips per trade to offset losses if the market moves
against you.

Avoid trading around data releases. Carrying a short− term position
into a data release is very risky because prices can gap sharply after
the release, blowing a short term strategy out of the water. Markets
are also prone to quick price adjustments in the 15 to 30 minutes
ahead of

major data releases as nearby orders are triggered. This can lead to a
quick shift against your position that may not be resolved before the
data comes out.

Medium−term directional trading

Medium−term positions are typically held for periods ranging anywhere
from a few minutes to a few hours, but usually not much longer than a
day. Just as with short−term trading, the key distinction for medium−
term trading is not the length of time the position is open, but the
amount of pips youre seeking/risking. Where short−term trading looks
to profit from the routine noise of minor price fluctuations, almost
without regard for the overall direction of the market, medium−term
trading seeks to get the overall direction right and profit from more
significant currency rate moves.

Almost as many currency speculators fall into the medium term category
(sometimes referred to as momentum trading and swing trading) as fall
into the short−term trading category. Medium−term trading requires
many of the same skills as short−term trading, especially when it
comes to entering/ exiting positions, but it also demands a broader
perspective, greater analytical effort, and a lot more patience.

Capturing intraday price moves for maximum effect The essence of
medium−term trading is determining where a currency pair is likely to
go over the next several hours or days and constructing a trading
strategy to exploit that view. Medium−term traders typically pursue
one of the following overall approaches, with plenty of room to
combine strategies:

Trading a view: Having a fundamental−based opinion on which way a
currency pair is likely to move. View trades are typically based on
prevailing market themes, like interest rate expectations or economic
growth trends. View traders still need to be aware of technical levels
as

part of an overall trading plan.

Trading the technicals: Basing your market outlook on chart patterns,
trend lines, support and resistance levels, and momentum studies.
Technical traders typically spot a trade opportunity on their charts,

FOREX−Trading−Strategy by Selzer−McKenzie                                 22
                               FOREX−Trading−Strategy by Selzer−McKenzie
but they still need to be aware of fundamental events, because theyre
the catalysts for many breaks of technical levels.

Trading events and data: Basing positions on expected outcomes of
events, like a central bank rate decision or a G7 meeting, or
individual data reports. Event/data traders typically open positions
well in advance of events and close them when the outcome is known.

Trading with the flow: Trading based on overall market direction
(trend) or information of major buying and selling (flows). To trade
on flow information, look for a broker that offers market flow
commentary, like that found in FOREX.coms Forex Insider Flow traders
tend to stay out of shortterm range−bound markets and jump in only
when a market move is under way.

When is a trend not a trend?

When its a range. A trading range or a range−bound market is amarket
that remains confined within a relatively narrow range of prices. In
currency pairs, a short−term (over the next few hours) trading range
may be 20 to 50 pips wide, while a longer−term (over the next few days
to weeks) range can be 200 to 400 pips wide. For all the hype that
trends get in various market literature, the reality is that most
markets trend no more than a third of the time. The rest of the time
theyre bouncing around in ranges, consolidating, and trading
sideways. Although medium−term traders are normally looking to capture
larger relative price movements say, 50 to 100 pips or more
theyre also quick to take smaller profits on the basis of short−term
price behavior. For instance, if a break of a technical resistance
level suggests a targeted price move of 80 pips higher to the next
resistance level, the medium−term trader is going to be more than
happy capturing 70 percent to 80 percent of the expected price move.
Theyre not going to hold on to the position looking for the exact
price target to be hit.

Long−term macroeconomic trading

Long−term trading in currencies is generally reserved for hedge funds
and other institutional types with deep pockets. Long−term trading in
currencies can involve holding positions for weeks, months, and
potentially years at a time. Holding positions for that long
necessarily involves being exposed to significant short−term
volatility that can quickly overwhelm margin trading accounts. With
proper risk management, individual margin traders can seek to capture
longer−term trends. The key is to hold a small enough position
relative to your margin balance

that you can withstand volatility of as much as 5 percent or more.

Carry trade strategies


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                             FOREX−Trading−Strategy by Selzer−McKenzie
A carry trade happens when you buy a high−yielding currency and sell a
relatively lower−yielding currency. The strategy profits in two ways:

By being long the higher−yielding currency and short the lower−
yielding currency, you can earn the interest rate differential between
the two currencies, known as the carry. If you have the opposite
position long the low−yielder and short the high−yielder the
interest−rate differential is against you, and it is known as the cost
of carry. Spot prices appreciate in the direction of the interest rate
differential. Currency pairs with significant interest rate
differentials tend to move in favor of the higher yielding currency as
traders who are long the high

yielder are rewarded, increasing buying interest, and traders who are
short the high yielder are penalized, reducing selling interest.

So let me get this straight, you may be thinking: All I have to do is
buy the higher−yielding currency/sell the lower−yielding currency, sit
back, earn the carry, and watch the spot price move higher? Whats the
catch? The catch is that downside spot price volatility can quickly
swamp any gains from the carry trades interest−rate different tial.
The risk can be compounded by excessive market positioning in favor of
the carry trade, meaning a carry trade has become so popular that
everyone gets in on it. Figure 3−1 illustrates the trending price
gains of a carry trade, punctuated by sudden price setbacks.

Carry trades usually work best in low−volatility environments, meaning
when financial markets are relatively stable and investors are forced
to chase yield. Keep in mind that carry trades need to have a
significant interest−rate differential between the two currencies
(typically more than 2 percent) to make them attractive. And carry
trades are definitely a long− term strategy, because depending on when
you get in, you may get caught in a downdraft that could take several
days or weeks to unwind before the trade becomes profitable again.

Figure 3−1: NZD/JPY trends higher in line with carry trade
fundamentals

(New Zealands interest rates are much higher than Japans), but it
meets sharp setbacks along the way.

Developing a Disciplined Trading Plan

No matter which trading style you decide to pursue, you need an
organized trading plan, or you wont get very far. The difference
between making money and losing money in the forex market can be as
simple as trading with a plan or trading with out one. A trading plan
is an organized approach to executing a trade strategy that youve
developed based on your market analysis and outlook. Here are the key
components of any trading plan:
Daily NZD/JPY Carry trades can see significant spot price gains

FOREX−Trading−Strategy by Selzer−McKenzie                                24
                             FOREX−Trading−Strategy by Selzer−McKenzie
punctuated by rapid price reversals.


Determining position size: How large a position will you take for each
trade strategy? Position size is half the equation for determining how
much money is at stake in each trade.

Deciding where to enter the position: Exactly where will you try to
open the desired position? What happens if your entry level is not
reached?
Setting stop−loss and take−profit levels: Exactly where will you exit
the position, both if its a winning position (take profit) and if
its a losing position (stop loss)? Stop loss and take−profit levels
are the second half of the equation that determines how much money is
at stake in each trade.


Thats it just three simple components. But its amazing how many
traders, experienced and beginner alike, open positions without ever
having fully thought through exactly what their game plan is. Of
course, you need to consider numerous finer points when constructing a
trading plan, and we focus on them more in the full version of
Currency Trading ForDummies. But for now, we just want to drive home
the point that trading without an organized plan is like flying an
airplane blindfolded you may be able to get off the ground, but how
will you land?

And no matter how good your trading plan is, it wont work if you
dont follow it. Sometimes emotions bubble up and distract traders
from their trade plans. Other times, an unexpected piece of news or
price movement causes traders to abandon their trade strategy in
midstream, or midtrade, as the case may be. Either way, when this
happens, its the same as never having had a trade plan in the first
place. Developing a trade plan and sticking to it are the two main
ingredients of trading discipline. If we were to name the one defining
characteristic of successful traders, it wouldnt be technical
analysis skill, gut instinct, or aggressiveness though theyre all
important. Nope, it would be trading disci−

pline. Traders who follow a disciplined approach are the ones who
survive year after year and market cycle after market cycle. They can
even be wrong more often than right and still make money because they
follow a disciplined approach.


Taking the Emotion Out of Trading

If the key to successful trading is a disciplined approach developing
a trading plan and sticking to it why is it so hard for many traders
to practice trading discipline? The answer is complex, but it usually
boils down to a simple case of human emotions getting the better of

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                            FOREX−Trading−Strategy by Selzer−McKenzie
them. Dont under estimate the power of emotions to distract and
disrupt. So exactly how do you take the emotion out of trading? The
simple answer is: You cant. As long as your heart is pumping and your
synapses are firing, emotions are going to be flowing. And truth be
told, the emotional highs of trading are one of the reasons people are
drawn to it in the first place. Theres no rush quite like putting on
a successful trade and taking some money out of the market. So just
accept that youre going to experience some pretty intense emotions
when youre trading.

The longer answer is that because you cant block out the emotions,
the best you can hope to achieve is understanding where the emotions
are coming from, recognizing them when they hit, and limiting their
impact on your trading. Its a lot easier said than done, but keep in
mind some of the following to keep your emotions in check: Focus on
the pips and not the dollars and cents. Dont be distracted by the
exact amount of money won or lost in a trade. Instead, focus on where
prices are and how theyre behaving. The market has no idea what your
trade size is and how much youre making or losing, but it does know
where the current price is.

Its not about being right or wrong; its about making money. The
market doesnt care if you were right or wrong, and neither should
you. The only true way of measuring trading success is in dollars and
cents. Youre going to lose in a fair number of trades. No trader is
right all of the time. Taking losses is as much a part of the routine
as taking profits. You can still be successful over time with a solid
risk−management plan.


Getting Started with Your


Practice Account



In This Chapter

Getting the most out of your practice account

Pulling the trigger

Managing the trade

Evaluating your results


The best way for newcomers to get a handle on what currency trading is
all about is to open a practice account. Almost every forex broker
offers a free practice

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                             FOREX−Trading−Strategy by Selzer−McKenzie


account to prospective clients; all you need to do is sign up for one
on the brokers Web site. Practice accounts are funded with virtual
money, so youre able to make trades with no real money at stake and
gain experience in how margin trading works. Practice accounts give
you a great chance to experience the forex market. You can see how
prices change at different times of the day, how various currency
pairs may differ from each other, and how the forex market reacts to
new information when major news and economic data is released. You
also can start trading in real market conditions without any fear of
losing money, experiment with different trading strategies to

see how they work, gain experience using different orders and managing
open positions, improve your understanding of how margin trading and
leverage work, and start analyzing charts and following technical
indicators. Practice accounts are a great way to experience the forex

market up close and personal. Theyre also an excellent way to test−
drive all the features and functionality of a brokers platform.
However, the one thing you cant simulate is the emotion of trading
with real money. To get the most out of your practice−account
experience, treat your practice account as if it were real money.

Pulling the Trigger

Its trigger−pulling time, pardner. This section assumes youve signed
up for a practice account at an online forex broker and youre ready
to start executing some practice trades. You make trades in the forex
market one of two ways: You can trade at the market, or the current
price, using the click−and deal feature of your brokers platform; or
you can employ orders, such as limit orders and one−cancels−the−other
orders (OCOs).


Clicking and dealing

Many traders like the idea of opening a position by trading at the
market as opposed to leaving an order that may or may not be executed.
They prefer the certainty of knowing that theyre in the market.
Actively buying and selling are also elements that make trading and
speculating as much fun as hard work. Most forex brokers provide live
streaming prices that you can deal on with a simple click of your
computer mouse. To execute a trade on those platforms:

1. Specify the amount of the trade you want to make.

2. Click on the Buy or Sell button to execute the trade.

The forex trading platform responds back, usually within a second or
two, to let you know whether the trade went through:


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                            FOREX−Trading−Strategy by Selzer−McKenzie
If the trade went through, youll receive a pop−up confirmation from
the platform and see your open position listing updated to reflect the
new trade. If the trade fails because the trading price changed before
your request was received, you receive a response indicating rates
changed, price not available, or something along those lines. You
then need to repeat the steps to make another trade attempt. Attempts
to trade at the market can sometimes fail in very fast−moving markets
when prices are adjusting quickly, like after a data release or break
of a key techni−

cal level or price point. Part of this stems from the latency effect
of trading over the Internet, which refers to time lags between the
platform price reaching your computer and your trade request reaching
the platforms server. If the trade fails because the trade was too
large based

on your margin, you need to reduce the size of the trade. Understand
from the get−go that any action you take on a trading platform is your
responsibility. You may have meant to click Buy instead of Sell, but
no one knows for sure except you.


Using Orders

Orders are critical trading tools in the forex market. Think of them
as trades waiting to happen, because thats exactly what they are. If
you enter an order and a subsequent price action triggers its
execution, youre in the market, so be as careful as you are thorough
when placing your orders in the market. Currency traders use orders to
catch market movements when theyre not in front of their screens.
Remember: The

forex market is open 24 hours a day, five days a week. A market move
is just as likely to happen while youre asleep or in the shower as
while youre watching your screen. If youre not a full−time trader,
then youve probably got a full−time job that requires your attention
when youre at work. (At least your boss hopes he has your attention.)
Orders are how you can act in the market without being there.
Experienced currency traders also routinely use orders to: Implement a
trade strategy from entry to exit Capture sharp, short−term price
fluctuations Limit risk in volatile or uncertain markets Preserve
trading capital from unwanted losses Maintain trading discipline
Protect profits and minimize losses

We cant stress enough the importance of using orders in currency
trading. Forex markets can be notoriously volatile and difficult to
predict. Using orders helps you capitalize on short term market
movements while limiting the impact of any adverse price moves. While
there is no guarantee that the use of orders will limit your losses or
protect your profits in all market conditions, a disciplined use of
orders helps you to

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                              FOREX−Trading−Strategy by Selzer−McKenzie


quantify the risk youre taking and, with any luck, gives you peace of
mind in your trading. Bottom line: If you dont use orders, you
probably dont have a well−thought−out trading strategy and thats a
recipe for pain.

Types of orders

Multiple types of orders are available in the forex market. Bear in
mind that not all order types are available at all online brokers, so
add order types to your list of questions to ask your prospective
forex broker.

Take−profit orders Dont you just love that name? An old market saying
goes, You cant go broke taking profit. Use take−profit orders to
lock in gains when you have an open position in the market. If youre
short USD/JPY at 117.20, your take−profit order will be

to buy back the position and be placed somewhere below that price, say
at 116.80 for instance. If youre long GBP/USD at 1.8840, your take−
profit order will be to sell the position some where higher, maybe
1.8875.

Limit orders A limit order is any order that triggers a trade at more
favor able levels than the current market price. Think Buy low, sell

high. If the limit order is to buy, it must be entered at a price
below the current market price. If the limit order is to sell, it must
be placed at a price higher than the current market price.

Stop−loss orders Boo! Sounds bad doesnt it? Actually, stop−loss
orders are critical to trading survival. The traditional stop−loss
order does just that: It stops losses by closing out an open position
that is losing money. Use stop−loss orders to limit your losses if the
market moves against your position. If you dont, youre leaving it up
to the market, and thats dangerous.

Stop−loss orders are on the other side of the current price from take−
profit orders, but in the same direction (in terms of buying or
selling). If youre long, your stop−loss order will be to sell, but at
a lower price than the current market price. If youre short, your
stop−loss order will be to buy, but at a higher price than the current
market.

Trailing stop−loss orders

You may have heard that one of the keys to successful trading is to
cut losing positions quickly, and let winning positions run. A
trailing stop−loss order allows you to do just that. The idea is that
when you have a winning trade on, you wait for the market to stage a
reversal and take you out, instead of trying to pick the right level

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                             FOREX−Trading−Strategy by Selzer−McKenzie
to exit on your own. A trailing stop−loss order is a stop−loss order
that you set at a fixed number of pips from your entry rate. The
trailing stopadjusts the order rate as the market price moves, but
only in the direction of your trade. For example, if youre long EUR/
CHF at 1.5750 and you set the trailing stop at 30 pips, the stop will
initially become active at 1.5720 (1.5750›0 pips).

If the EUR/CHF price moves higher to 1.5760, the stop adjusts higher,
pip for pip, with the price and will then be active at 1.5730. The
trailing stop continues to adjust higher as long as the market
continues to move higher. When the market puts in a top, your trailing
stop will be 30 pips (or whatever distance you specify) below that
top, wherever it may be.

If the market ever goes down by 30 pips, as in this example, your stop
will be triggered and your position closed. So in this case, if youre
long at 1.5750 and you set a 30−pip trailing stop, the stop initially
becomes active at 1.5720. If the market never ticks up and goes
straight down, youll be stopped out at 1.5720. If the price first
rises to 1.5775 and then declines by 60 points, your trailing stop
will have risen to 1.5745 (1.5775›0 pips) and thats where youll be
stopped out. Pretty cool, huh?

One−cancels−the−other orders

A one−cancels−the−other order (more commonly referred to as an OCO
order) is a stop−loss order paired with a take−profit order. An OCO
order is the ultimate insurance policy for any open position. Your
position stays open until one of the order levels is reached by the
market and closes your position.

When one order level is reached and triggered, the other order
automatically cancels.Lets say youre short USD/JPY at 117.00. You
think if it goes up beyond 117.50, its going to keep going higher, so
thats where you decide to place your stop−loss buying order. At the
same time, you believe that USD/JPY has downside potential to 116.25,
so thats where you set your take−profit buying order. You now have
two orders bracketing the market and your risk is clearly defined. As
long as the market trades between 116.26 and 117.49, your position
remains open. If 116.25 is reached first, your take profit triggers
and you buy back at a profit. If 117.50 is hit first, then your
position is stopped out at a loss. OCO orders are highly recommended
for every open position.


Managing the Trade

So youve pulled the trigger and opened up the position, and now
youre in the market. Time to sit back and let the market do its
thing, right? Not so fast, amigo. The forex market isnt a roulette
wheel where you place your bets, watch the wheel spin, and simply take

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                            FOREX−Trading−Strategy by Selzer−McKenzie
the results. Its a dynamic, fluid environment where new information
and price developments create new opportunities and alter previous
expectations.

We hope youll take to heart our recommendations about always trading
with a plan identifying in advance where to enter and where to exit
every trade, on both a stop−loss and take−profit basis. Bottom line:
You improve your overall chances of trading success (and minimize the
risks involved) by thoroughly planning each trade before getting
caught up in the emotions and noise of the market. Depending on the
style of trading youre pursuing (short−term versus medium− to long−
term) and overall market conditions (range−bound versus trending),
youll have either more or less to do when managing an open position.
If youre following a medium− to longer−term strategy, with generally
wider stop−

loss and take−profit parameters, you may prefer to go with the set it
and forget it trade plan youve developed. But a lot can happen
between the time you open a trade and prices hitting one of your trade
levels, so staying on top of the market is still a good idea, even for
longer−term trades.


Monitoring the Market while Your Trade Is Active
No matter which trading style you follow, it pays to keep up with
market news and price developments while your trade is active.
Unexpected news that impacts your position may come into the market at
any time. News is news; by definition, you couldnt have accounted for
it in your trading plan, so fresh news may require making changes to
your trading plan. When we talk about making changes to the trading
plan, were referring only to reducing the overall risk of the trade,
by taking profit (full or partial) or moving the stop loss in the
direction of the trade. The idea is to be fluid and dynamic in one
direction only: taking profit and reducing risk. Keep your ultimate
stop−out point where you decided it should go before you entered the
trade.



Staying alert for news and data developments

If your trade rationale is reliant on certain data or event
expectations, you need to be especially alert for upcoming reports on
those themes.

Part of your calculus to go short EUR/USD, for instance, may be based
on the view that Eurozone inflation pressures are receding, suggesting
lower Eurozone interest rates ahead. If the next days Eurozone
consumer price index (CPI) report confirms your view, the fundamental
basis for maintaining the strategy is reinforced. You may then
consider whether to increase your take−profit objective depending on

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                             FOREX−Trading−Strategy by Selzer−McKenzie
the markets
reaction. By the same token, if the CPI report comes out unexpectedly
high, the fundamental basis for your trade is seriously undermined and
serves as a clue to exit the trade earlier than you originally
planned. Every trade strategy needs to take into account upcoming news
and data events before the position is opened. Ideally, you should be
aware of all data reports and news events scheduled to occur during
the anticipated time horizon of your trade strategy. You should also
have a good understanding of what the market is expecting in terms of
event out comes to anticipate how the market is likely to react.


Keeping an eye on other financial markets

Forex markets function alongside other major financial markets, such
as stocks, bonds, and commodities (e.g. gold, oil, etc.). Important
fundamental and psychological relationships (discussed more in Chapter
1) exist between other markets and currencies, especially the U.S.
dollar, so look to developments in other financial markets to see
whether they confirm or contradict price moves in the dollar pairs.

Evaluating Your Trading Results

Regardless of the outcome of any trade, you want to look back over the
whole process to understand what you did right and wrong. In
particular, ask yourself the following questions:

How did you identify the trade opportunity? Was it based on technical
analysis, a fundamental view, or some combination of the two? Looking
at your trade this way helps identify your strengths and weaknesses as
either a fundamental or technical trader. For example, if technical
analysis generates more of your winning trades, youll probably want
to devote more energy to that approach.

How well did your trade plan work out? Was the position size
sufficient to match the risk and reward scenarios, or was it too large
or too small? Could you have entered at a better level? What tools
might you have used to improve your entry timing? Were you patient
enough,

or did you rush in thinking youd never have the chance again? Was
your take profit realistic or pie in the sky? Did the market pay any
respect to your choice of take−profit levels, or did prices blow right
through it? Ask yourself the same questions about your stop−loss
level. Use the

answers to refine your position size, entry level, and order placement
going forward.

How well did you manage the trade after it was open?


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                            FOREX−Trading−Strategy by Selzer−McKenzie
Were you able to effectively monitor the market while your trade was
active? If so, how? If not, why not? The answers to those questions
reveal a lot about how much time and dedication youre able to devote
to your trading. Did you modify your trade plan along the way? Did

you adjust stop−loss orders to protect profits? Did you take partial
profit at all? Did you close out the trade based on your trading plan,
or did the market surprise you somehow? Based on your answers, youll
learn what role your emotions may have played and how disciplined

a trader you are. There are no right and wrong answers in this review
process; just be as honest with yourself as you can be. No one else
will

ever know your answers, and you have everything to gain by identifying
what youre good at, what youre not so good at,

and how you as a currency trader should best approach the
market.Currency trading is all about getting out of it what you put
into it. Evaluating your trading results on a regular basis is an
essential step in improving your trading skills, refining your trading
styles, maximizing your trading strengths, and minimizing your trading
weaknesses
.




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